AS 6 DEPRECIATION ACCOUNTING

Applicability

AS 6 though an old accounting standard is considered very significant, as it affects the preparation
and presentation of financial statements for all enterprises. For the same reason, AS 6 is made
applicable to all level of enterprises i.e. it applies in its entirety to level I, II, and III enterprises.

Issue 1 :

To which assets, AS 6 Depreciation Accounting is not applicable ?

AS 6 applies to all depreciable assets except the following items to which special
considerations apply

(i) forest, plantations and similar regenerative natural resources.

(ii) wasting assets including expenditure on the exploration for and extraction of minerals,
oils, natural gas and similar non-regenerative resources.

(iii) expenditure on research and development

(iv) Good will

(v) live stock

(vi) Land, unless it has a limited useful life to the enterprise.

Issue 2 :

Which are the three factors usually considered in computation of depreciation and the amount to be
charged in respect thereof in the accounting period ?

Computation of depreciation and the amount to be charged in respect thereof in an accounting

period are usually based on the following three factors :
(i) historical cost or other amount substituted for the historical cost of the depreciable asset
when the asset has been revalued.
(ii) expected useful life of the depreciable asset and
(iii) estimated residual value of the depreciable asset.

Issue 3 :
Can there be any factors which determine whether useful life of an asset is shorter than its physical
life?

Under the following circumstances, useful life of a depreciable asset is shorter than its physical
life and is :
(i) Pre-determined by legal or contractual limits such as the expiry dates of related leases.
(ii) Directly governed by extraction or consumption
(iii) dependent on the extent of use and physical deterioration on account of wear and tear
which again depends on operational factors, such as the number of shifts for which
the asset is to be used, repair and maintenance policy of the enterprise etc. and
(iv) reduced by obsolescence arising from such factors as :
 (a) technological changes
(b) improvement in production methods
(c) change in market demand for the product or service output of the asset or
(d) legal or other restrictions.

Issue 4 :
Is depreciation required to be charged in each accounting period irrespective of the fact that the
assets market value has increased?

Depreciation has a significant effect in determining and presenting the financial position and
results of operations of an enterprise. Depreciation is charged in each accounting period by
reference to the extent of the depreciable amount, irrespective of an increase in the market
value of asset.
Thus, depreciation will have to be provided for each accounting year, irrespective of the fact
that the market value of Fixed Assets has increased. For recognising market value of fixed
assets, AS 10 permits revaluation of fixed assets.

Issue 5 :

A Ltd. engaged in production of steel, wants to provide for deprecation based on unit of production
instead of straight line or written down value method. Can A Ltd. do so ?

AS 6, on Depreciation accounting stipulates that minimum depreciation should be provided as

made under statute i.e. the Companies Act, 1956. Schedule XIV to the Companies Act, 1956
prescribes various rates to be provided for different assets under straight line and written-down
value method. However, where management estimates useful life of an asset shorter than as
envisaged under the provisions of statute i.e. schedule XIV, than the depreciation is provided
applying a higher rate.
Thus, if A Ltd. contemplates to provide deprecation on production basis and such depreciation
happens to be lower than the depreciation worked out under schedule XIV, than A Ltd. would
not be complying with the provisions of AS 6. Since, under the Indian Accounting Standard,
reference is made to statute, companies in India will be required to provide minimum
depreciation at the rates prescribed in schedule XIV. Based on the estimated useful life, if the
depreciation rate is lower than the rate prescribed in Schedule XIV, companies will be required
to approach central government in this regards.
Note : Under the International accounting standard or for that purpose US GAAP, depreciation
is provided considering the best estimate of useful life of the asset. The following abstract from
the financial statement of Cathay Pacific Airways will show that enterprise is at liberty to
evaluate the estimate useful life of Fixed Asset.
Annual depreciation charges to write down the original cost of aircraft to estimated residual
values are based on actual operational usage of the relevant aircraft as a proportion of its total
estimated operational life. The useful operational life of an aircraft is determined by reference
to its anticipated aircraft flight cycle while in service of the company. However, if the aircraft is
held under a finance lease, the depreciable life of the aircraft is limited to the lease term unless
a purchase option is held. A flight cycle is defined as one take-off and one landing. The
residual value of aircraft and related equipment are 10% of original cost or values guaranteed
under forward sales agreements.
Issue 6 :
R. Ltd. a newly incorporated company wants to provide depreciation on Plant and Machinery on
straight line method whereas written down value method for the remaining fixed assets? Can R Ltd. do
so ?

Depreciation method is selected based on various important factors e.g. (i) type of asset, (ii)
the nature of the use of such asset and (iii) circumstances prevailing in the business.
AS 6, mentions, a combination of more than one method is some times used, meaning thereby
that for few fixed assets straight line method can be adopted whereas for other fixed assets
written down value method can also be adopted.
Accordingly R Ltd. can choose straight line method for plant and machinery and written down
value method for other fixed assets.

Issue 7 :

P Ltd. is providing deprecation on straight line method. Due to technical evaluation, the estimated
useful life of certain fixed assets is less as compared to life of assets as indicated by rates prescribed
in schedule XIV of the Companies Act, 1956. Is P Ltd. required to provide depreciation considering the
estimated useful life of asset which is higher than the rates prescribed in schedule XIV of the
Companies Act, 1956. Is P Ltd. required to recompute depreciation from inception i.e. from the date
when such fixed assets were purchased?

AS 6 Stipulates that where the managements estimate of the useful life of an asset of the
enterprise is shorter than that envisaged under the provisions of the relevant statute i.e.
Schedule XIV, the depreciation provision is appropriately computed by applying a higher rate.
Hence, P Ltd. will be required to provide depreciation at higher rates than rates prescribed in
schedule XIV.
Second and important issue that arises, how P Ltd. should compute the depreciation ? Since,
this gives rise to a change in estimate and not a change in method, enhanced depreciation
should be provided prospectively i.e. over the remaining useful life of the asset.
P. Ltd. will have to provide enhanced depreciation over the residual useful life of the asset.

Issue 8 :
P Ltd. was providing depreciation on Plant and Machinery on written down value method. With effect
from 1-4-03, in respect of additions to, plant and machinery, P Ltd. wants to provide depreciation on
straight line method, whereas for plant and machinery upto 31-3-03, it will continue to provide
depreciation on written down value method. Is contention of P. Ltd. justified ?

As per AS 6, the method of depreciation is applied consistently to provide comparability of the

results of the operation of the enterprise from period to period. A change from one method of
providing depreciation to another is made only if the adoption of the new method is required by
statute or for compliance with an accounting standard or if it is considered that the change
would result in a more appropriate preparation or presentation of the financial statements of the
enterprise. When such a change in method of depreciation is made, depreciation is
recalculated in accordance with the new method from the date of the asset coming into use.

Accordingly, P Ltd. would not be justified in providing depreciation on straight line method in
respect of additions to plant and machinery with effect from 1-4-03. P Ltd. can change method
of providing depreciation from written down value to straight line method and this in compliance
to Accounting Standard has to be done retrospectively from the date of the asset coming into
use.
Issue 9 :
S Ltd. revalues the fixed assets in conformity with AS 10, fixed assets, with effect from 1-4-03. S Ltd.
is following straight line method of depreciation at the rates prescribed in schedule XIV of the
Companies Act, 1956. Should S Ltd. continue to provide depreciation at the rates prescribed in
schedule XIV for the revalued assets ?

As per AS 6, where the depreciable assets are revalued, the provision for depreciation should
be based on the revalued amount and on the estimate of the remaining useful lives of such
assets. Accordingly S Ltd. will have to provide deprecation on revalued assets considering the
estimate of the remaining useful lives of such assets. Accordingly S Ltd. will have to provide
depreciation on revalued assets considering the estimate of the remaining useful lives of such
assets and not at the rate as prescribed in schedule XIV of the Companies Act 1956, as hither
to followed.

In connection therewith, S Ltd. will also be required to provide depreciation on the total book
value of the fixed assets, including the increased amount as a result of revaluation in the profit
and loss account of the relevant period. S Ltd. can have option to transfer an amount
equivalent to the additional depreciation from the Revaluation Reserve. Such transfer from
Revaluation Reserve should be shown in the Profit and Loss account separately.

Issue 10 :
In case of addition to fixed assets, which otherwise forms an integral part of the existing asset, how is
depreciation provided on such addition ?
AS 6, Depreciation accounting states that any addition or extention to an existing asset which
is of a capital and which becomes an integral part of the existing asset is depreciated over the
remaining useful life of that asset.
However, any addition or extention which retains a separate identity and is capable of being
used after the existing asset is disposed of, is depreciated independently on the basis of an
estimate of its own useful life.

Issue 11 :
M Ltd. is in manufacturing of steel. M Ltd. is following written-down value method for providing
depreciation. During accounting year 03-04, M Ltd. commenced manufacturing cement. Cement
division of M Ltd. wants to provide depreciation on straight line method. Can M Ltd. do so ?
AS 6, mentions that the management of a business selects the most appropriate method(s)
based on various important factors e.g. (i) type of asset (ii) the nature of the use of such asset
and (iii) circumstances prevailing in the business. Since, the Fixed Assets of cement division
are not similar in nature and use as that of steel division, M Ltd. can follow a straight line
method of depreciation for cement division.
Issue 12 :

What are the disclosure requirements required by AS 6 Depreciation accounting?

Over and above the requirements of schedule VI of the Companies Act 1956, AS 6 requires
the following information to be disclosed in the financial statements :

(i) the historical cost or other amount substituted for historical cost of each class of
depreciable assets.
(ii) total depreciation for the period for each class of assets,
(iii) the related accumulated depreciation
(iv) accounting policy as to the depreciation method used and the depreciation rates or the
useful lives of the assets, if they are different from the principal rates specified in the
statute governing the enterprise.
 Depreciation vis--vis Amortisation :

The accounting profession as well as the industry in India, have been extensively using
only one terminology i.e. Depreciation. However, over last few years the concept of
amortisation is gaining equal importance. The words depreciation and amortisation are
used for different assets. For fixed assets of tangible nature such as Building, Plant and
Machinery, Vehicles, Furniture & Fixtures the word depreciation is used, whereas fixed
assets of intangible nature such as Patents, Trade Marks, Goodwill, Software, Technical
know-how etc. the word amortisation is used. AS 6 specifically deals with depreciation
where as AS 26, deals with Intangible assets and its amortisation. Thus, now we have
different accounting standards which deal with write-off of fixed assets either in form of
depreciation or amortisation. The rates of write-off will again differ depending upon various
factors. As regards depreciation is concerned, in India ready made rates are made
available in schedule XIV of the Companies Act, 1956. Whereas AS 26 which is of
recent origin, permits amortisation based on

Managements estimate of useful life of the asset, but not to exceed ten years except
where there is a persuasive evidence that the useful life of an intangible asset will be a
specific period longer than ten years.

Both Tangible and Intangible assets are shown under the head fixed assets but presented
separately. Thus, now we encounter the word Depreciation and Amortisation instead of
one terminology Depreciation. Disclosure requirements of AS 6, Depreciation Accounting
and AS 26, Intangible Assets have to be complied with in presentation of financial
statements.

With AS 26 becoming applicable w.e.f. 1-4-03 for listed companies, a common item say
Goodwill or Trade Mark appearing in Financial Statements is subject to amortisation.
Thus, intangible assets such as Goodwill or Trademark can no more be carried indefinitely
in financial statements at cost.